Stock market rally puts floor under the carry trades for the moment. AUD surges the most.

The change of momentum may not last long. USD view still in limbo.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• New Zealand kept interest rates unchanged at 8.25% as expected.
• New Zealand Dec. Business PMI fell to 53.8 vs. revised 56.7 in Nov.
• Japan Adj. Merchandise Trade Balance out at ¥642.5B vs. ¥700B expected.
• China Q4 GDP rose 11.2% vs. 11.3% expected.
• China Dec. PPI rose 5.4% YoY vs. 4.8% expected.
• China Dec. Retail Sales rose 20.2% vs. 18.6%  expected.

THEMES TO WATCH – UPCOMING SESSION
Key event risks today (all times GMT):

• Sweden PPI (0830)
• Germany Jan. IFO (0900)
• UK Dec. BBA Loans for House Purchase (0930)
• US Weekly Initial Jobless Claims (1330)
• US Dec. Existing Home Sales (1500)
• US Weekly Crude Oil and Product Inventories (1530)
• EuroZone ECB's Trichet to speak (1620)
• Japan Jan. Tokyo CPI and Dec. National CPI (2350)
• Japan BoJ to publish minutes of 20 Dec. meeting (2350)
• New Zealand RBNZ's Bollar to speak (0030)

Market Comments

After probing the recent lows in yesterday's session, US stocks surged later in the session, with the S&P500 rising more than 6% from the lows into the close. Credit for the rise was given to news that the bond insurers like Ambac and MBIA met with New York insurance regulators to discuss stabilization of their finances. Since the bond insurer story was perhaps the key spark that kicked off the last swoon in the markets, then it makes sense for a bounce to materialize on the news of a potential bailout. But the big picture review remains: the stock market and economy will not move over a longer period on stories like this (the Fed is always going to bail out players involved in the really dangerous systemic risks anyway), it will move on whether consumers still have the mojo to run out and spend when they've been overextended for too long, their asset base in home equity (and now stocks!) is crumbling, and their banks are unwilling to extend credit on favorable terms, if at all. Perhaps rhetorical questions...

In any case, equity traders know that bear markets are very tough to trade as volatility is absolutely enormous and viciously fraught with momentum changes - sharp rallies within an overall downward move. These moves are mirrored in FX in the carry trades, so we look for these to find a top with the assumption that equities find a top and continue lower at some point. The tough part is finding good entry points and stop placement, as increase volatility means that trades may be quickly stopped out even if the directional call proves accurate at the end of the day. Considering the volatility, traders need to watch their leverage. Trades like AUDCHF and AUDJPY will be the most volatile as these represent the two poles of the risk spectrum.

Trichet was out speaking yesterday, but there was little new in his comments, again he reiterated the risks of second round effects (here he is worried about approaching IG Metall talks, as this is the orld's biggest union and it is out asking for 8% pay increases), but also mentioned the downside risks to growth. Again, the STIR market continues to place bets that the ECB will cut rates, though this morning the Euribor strip is opening lower to price in yesterday's stock market rally.

The USD is still in limbo as we look at whether this bounce in equities is a dead cat bounce that soon fades, or whether we're in for a more range trading environment. We expect the USD to eventually rally, but the focus at the moment seems mostly be on the JPY crosses broadly and the commodity currencies as these are the most sensitive to equity moves. EURUSD needs to drop below 1.4485 and then 1.4350 to reinvigorate the prospects of a bigger USD move stronger.

Keep an eye on the IFO release today  - possibly key for the EUR vs. USD and GBP. GBP oddly found no support on yesterday's combination of a more hawkish than expected BOE vote at the last meeting (8-1 rather than the expected 7-2) and a stronger than expected GDP report.

Chart: USDJPY

USDJPY - what next? USDJPY Is in a clear down trend, but recent action (fading momentum and yesterday's doji/hammer pattern that seems to have rejected new lows for now) suggests that a bit of consolidation may be in order. A few levels to consider are 107.30 - the old low and close to the post FOMC cut high. Then we have 107.90, the more recent low. Beyond that, we look at 108.66, the first big Fibo retracement level for the move down from the 114.64 top to yesterday's 105.00 area low. Again, here we're just mulling re-entry points for the down trend, if the pair crumbles back below 105.00 without further ado, that would negatve the consolidation scenario. EURJPY is likely to be a higher beta version of this trade.